Riyadh looks to the long term

15 January 2010

The Oil Ministry plans to double the country’s refining capacity by 2015 in a bid to become the supplier of choice for the booming economies of Asia

Having spent five years ramping up its crude oil production, Riyadh is now planning a wave of downstream projects to overhaul and expand Saudi Arabia’s oil refining capacity. Visiting China in November last year, Saudi Oil Minister Ali al-Naimi said the kingdom’s downstream investment drive would double its current refining capacity by 2015.

The kingdom is currently the world’s sixth largest oil refiner, with a capacity of 2.1 million barrels a day (b/d) from its seven domestic facilities. State-owned energy company Saudi Aramco, which currently has a refining capacity of 1.75 million b/d, plans to increase its domestic capacity to 3 million b/d by 2015.

The expansion will focus on the industrial port cities of Jubail and Yanbu, where two new refineries with a combined capacity of 800,000 b/d will be built by 2014.

Much of the new capacity will turn the kingdom’s vast reserves of heavy crude into gasoline, diesel and jet fuel, as well as other petroleum products for export to Europe and Asia.

French liaison

The most advanced of the kingdom’s refinery projects is a joint venture between Aramco and French energy firm Total. In May 2008, the two companies confirmed their decision to invest in the construction of the Jubail refinery on the kingdom’s Gulf coast.

Aramco holds a 62.5 per cent stake in the project, while Total has the remaining 37.5 per cent. A public offering could be floated within two years of the project start-up in 2013, which would reduce Aramco’s stake to 37.5 per cent.

The Jubail refinery will have a capacity of 400,000 b/d, supplied by pipelines from two giant offshore fields, Manifa and Safaniyah, which have oil reserves of approximately 11 billion and 19 billion barrels respectively.

When it opens at the end of 2013, the Jubail refinery will be the first in the kingdom to produce jet fuel, as well as ultra-low sulphur diesel to meet stringent fuel specifications in the Asian and European markets. The project will also include a 700,000 tonnes-a-year (t/y) petrochemicals complex to produce paraxylene, propylene and benzene.

Engineering, procurement and construction (EPC) costs for the project are $9.6bn. The fact that it is sponsored by two heavyweights of the energy sector, Aramco and Total, helped its bid for financing, which is on track to close in the early months of this year.

Nearly $10bn of funding has been secured from domestic and international banks, export credit agencies and others. Funding will include an Islamic bond (sukuk), to be issued in early 2010, which could raise more than $500m.

Aramco has also formed a joint venture with US oil major ConocoPhillips for a second 400,000 b/d refinery to be built at Yanbu. This is expected to begin operations in 2014. Each partner will hold a 35 per cent equity stake in the venture, with the remaining 30 per cent to be offered for public subscription. The refinery will supply the US with high-quality gasoline, while low-sulphur diesel will be exported to Europe and naphtha to Asia.

A number of other downstream projects are also planned, but their prospects for completion are not so certain.

The 250,000-400,000 b/d Jizan refinery is planned as the kingdom’s first privately owned refinery and is part of Riyadh’s wider plan to develop its southwestern region near the border with Yemen. But there are concerns among analysts over whether the project will attract the private sector investment required, estimated at $7bn.

“I have always been bearish on the prospects for this refinery,” says Stephen George, a refining analyst at UK-based KBC Energy Economics. “There is a strategic logic in the Saudis’ desire to build it, but it is not the most attractive private sector investment.

“Yanbu is state-owned, and the state can tweak the economics to make sure the project is viable. Does anyone in the private sector refinery business think it can go head-to-head with Aramco?”

The Jizan project will need massive capital investment for infrastructure, roads and a deep-water port. Even though the Oil Ministry and the Jizan governorate have said firms would be offered cheap loans of up to $4bn and tax breaks as an incentive to invest, initial interest from international firms has dwindled since the scheme was first mooted in 2006. The project has suffered delays as a result.

Bids were initially planned for the second half of 2007, but the schedule is now unclear.  So far, two Saudi-owned firms have bid for the $7bn contract to build, own and operate the refinery. The local National Industrialisation Company (Tasnee) and Corral Petroleum Holdings both filed prices by the 7 November 2009 bid deadline.

On 9 December last year, speaking at the Gulf Petrochemicals & Chemicals Association Forum in Dubai, Al-Naimi said an award would be made on Jizan “hopefully by the end of the year”, but this has yet to happen.

Job creation

Riyadh is keen to see progress on Jizan and not just to raise refining capacity. Job creation is a preoccupation for the government and the energy sector is considered to have a part to play in generating employment for Saudi nationals. “I think refinery economics is probably secondary to employment for Riyadh at the moment,” says George.

When the above refinery projects were announced in 2006, the prospects were very different from today’s. “This was a world which thought it was running out of refining capacity and was optimistic about continued strong growth in oil demand,” says George.

But, while demand for oil has dropped since the economic boom of the mid 2000s, the Saudis are eager to keep the projects moving forward in anticipation of a return to high demand for oil.

In November 2008, both the Yanbu and Jubail refineries were put on hold as Aramco sought to cut costs in an overheated EPC market. The move paid off, enabling it to cut as much as 20 per cent from its EPC costs for the two refinery schemes. Predictions for the year ahead might be -bearish, but most analysts predict healthier economic conditions will prevail by the time the Jubail and Yanbu projects come on stream in 2014.

The technology being installed at the two refineries will allow Saudi Arabia to refine heavy crude, which currently sells at a discount to the lighter grades.

Both the Jubail and Yanbu refineries will include coking units, allowing them to use even the densest oil.

In the long term, assuming oil demand continues to grow, the market for Saudi Arabia’s heavy crudes will also grow. According to global oil field services company Schlumberger, about 40 per cent of the world’s remaining oil resources are heavy or extra-heavy crude.

“Refiners are investing in bottom-of-the-barrel refining, with the purpose of putting flexibility into their processes. The strategic intention is to be able to refine whatever there is to refine,” says George.

Aramco’s overseas refinery investments show another side of the downstream investment picture. More than a third of the kingdom’s refining capacity, 1.75m b/d, currently lies outside the kingdom, in the US, Greece, South Korea, China and the Philippines. Increasingly, global refining is shifting east. The Paris-based International Energy Agency forecasts that Asia will double its current consumption of 820,000 b/d of fuel oil to about 2 million b/d by 2013.

In 2008, some 54 per cent of Saudi’s refined product exports were destined for the Asia-Pacific region. The increasing number of visits to the region by Saudi officials, including the oil minister, shows how important the region is to -Riyadh.

In June 2008, Aramco agreed to increase the kingdom’s supply of oil to China to 1.5 million b/d by 2015, from 740,000 b/d, which will make it the country’s top supplier.

To this end, in 2007, Aramco, the US’ ExxonMobil and state-owned China Petroleum & Chemical Corporation (Sinopec) signed a $3.5bn agreement to expand the capacity of the Quanzhou refinery in Fuijian province in the southeast of China.

The deal with Sinopec represents an attractive investment for Aramco - a growing market and a guaranteed, steady outlet for its crude.

“It gives [Aramco] a nice way to increase its footprint in the region,” says George.

Market conditions for investment in downstream projects may not be the most appealing today, but the current dip in global demand for oil is of little concern to Aramco’s long-term growth strategy.

The new refineries are a step in the company’s evolution from being principally an oil and gas producer to becoming a fully integrated company with significant assets along the entire downstream chain - refining, shipping and distribution.

Its overseas assets will, Riyadh hopes, ensure that the kingdom becomes the supplier of choice to meet Asia’s growing energy demands.

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